Engineering

Economy

Chapter 3: Cost Estimation Techniques

Objective ;

Present various methods / techniques

which are useful for estimating the
costs for an engineering economy
study.
Results of cost estimating can be
used for;

• Setting selling prices for quoting, bidding,

or evaluating contracts.

• Determining if a proposed product can be

made and distributed at a profit.
 The two fundamental approaches to
cost estimating “top-down” and
“bottom-up.”
• Top-down uses historical data from similar
projects.

• Bottom-up is more detailed method and works

best when the detail concerning the desired
output (product or service) has been defined and
clarified.
HOW??
Unfortunately
The cost estimation approach has three
major components;

1. Work breakdown structure (WBS)

2. Cost and revenue structure (classification)
3. Estimating techniques (models)
 Work Breakdown Structure (WBS)

• Also called work element

structure
• A framework for defining
all project work elements
and their relationships
• Developing relevant cost
and revenue data, and
management activities.
• Each level of a WBS divides
the work elements into
increasing detail.
YOU NEED TO DO IT IN YOUR FINAL
PROJECT
Example; Construction of a small commercial
building
Cost and Revenue Structure
• Used to identify and categorize the costs and
revenues that need to be included in the
analysis.
• WBS are important aids in developing the cost
and revenue structure for a project.
• Perhaps the most serious source of errors in
developing cash flows is overlooking
important categories of costs and revenues.
Some categories of costs and revenues
which you have to make sure it is accurate
1. Labour costs
2. Renting costs
3. Material costs
4. Maintenance costs
5. Property taxes and insurance
6. Market (or salvage) values
7. Overhead costs (costs not directly related to the manufacture of a product or delivery of a service
e.g.. rent to administrative costs to marketing costs )

8. Disposal costs
9. Revenues based on sales, etc.
10. Quality (and scrap) costs
 Estimating Techniques
REMEMBER! The purpose of estimating is to develop cash-
flow projections—not to produce exact data about the
future, which is virtually impossible.

Cost and revenue estimates can be classified according to

detail, accuracy, and their intended use.

• Order-of-magnitude estimates; initial

evaluation stage of a project (±30%)
• Semidetailed, or budget, estimates (±15%)
• Definitive (detailed) estimates (±5%)
The level of detail and accuracy of
estimates depends on
• Time and effort available as justified by the
importance of the study,
• Difficulty of estimating the items in question,
• Methods or techniques employed.
• Qualifications of the estimator(s), and
• Sensitivity of study results to particular factor
estimates.
Cost of estimate vs Accuracy
• As estimates become more detailed making the estimate cost
increases dramatically.
A variety of sources exist for cost
and revenue estimation.
• Accounting records: good for historical data, but
limited for engineering economic analysis.
• Other sources inside the firm: e.g., sales, engineering,
production, purchasing.
• Sources outside the firm: Government data, industry
surveys, trade journals, and personal contacts.
• Research and development: e.g., test marketing
program, surveys.
These models can be used in estimates;
order-of magnitude and
semi-detailed budget estimates

•Indexes
•Unit technique
•Factor technique
•Parametric (Power-sizing and Learning curve)
 Indexes, I, provide a means for developing
present and future cost and price estimates
from historical data.

Cn = estimated cost or price of item in year n.

Ck = cost or price of item in reference year (older) k (n>k).
k = reference year for which cost or price is known.
n = year for which cost or price is to be estimated (n>k) in the future.
I = Indexes in specific year

Indexes can be created for a single item or for multiple

items.
The developer of an index can assign
different weights to the items in the index
according to their contribution to total cost.
 Unit Technique
• Capital cost of plant per kilowatt of capacity
• Construction cost per square foot
• Capital cost per installed telephone
• Revenue per customer served
• Temperature loss per 1,000 feet of steam pipe
• Operating cost per mile

When multiplied by the appropriate unit, give a total

estimate of cost, savings, or revenue.
Factor technique
The factor technique is an extension of the unit
technique where the products of several
quantities are summed and then added to
components estimated directly.

C = cost being estimated

Cd = cost of the selected component d estimated directly
fm = cost per unit of component m
Um = number of units of component m
Example
Estimate the cost of a house consisting of 2,000
square feet, two porches, and a garage. Using a unit
factor of $85 per square foot, $10,000 per porch,
and $8,000 per garage

The total estimate

$8,000 + ($10,000 × 2) + ($85 × 2,000) = $198,000.

Porch: a covered shelter projecting in front of the entrance of a building.

Two commonly used to develop cost estimating
relationships (CERs);

Power-sizing technique
Learning curve.
 The power-sizing technique (or exponential
model) is frequently used for developing
capital investment estimates for industrial
plants and equipment.

(both in $ as of the point in time

for which the estimate is desired)
(both in the same physical units)

The value of the cost-capacity factor will depend on the type of plant or
equipment being estimated. For example, X = 0.68 for nuclear generating
plants and 0.79 for fossil-fuel generating plants.
 Example
200-MW plant cost $300 million, find that the
current cost of a 100-MW plant assuming the
cost-capacity factor for a fossil-fuel power plant
is 0.79.
Learning Curve

Reflects increased efficiency and

performance with repetitive production
of a good or service.

The concept is that some input resources

decrease, on a per-output-unit basis, as
the number of units produced increases.
learning curve
Most learning curves assume a constant percentage
reduction occurs as the number of units produced is
doubled.

Tx: The total time needed to assemble unit number x

Example
Assume the first unit of production required 3 hours
time for assembly. The learning rate is 75%. Find
(a) The time to assemble the 8th unit, and

(b) The total time needed to assemble the first 6 units

(u=1,2,3,4,5,6).
Quiz;

Assume the first unit of production required

3 hours time for assembly. The learning rate
is 75%. Find ;
The total time needed to assemble the first 6
units (u=1,2,3,4,5,6).

3(1+0.75+0.633+0.563+0.513+0.475)
Solar costs will fall 60% over next decade
he International Renewable Energy Agency (IRENA) believes
that Solar cost will fall 60% lower than today’s prices within a
decade.

https://www.pv-magazine.com/2017/10/23/solar-costs-will-fall-60-over-next-decade-to-fuel-pv-
adoption-says-irena-head/
Solar costs will keep falling
New Solar Innovation Cuts Costs By
60% While Increasing Efficiency By
24%

A novel technique developed by the

California-based solar manufacturing
company Rayton Solar might be able to cut
the cost of production by a 60% while
increasing efficiency of solar panels to 24%.
http://www.iflscience.com/technology/new-solar-innovation-cuts-costs-by-60-while-
increasing-efficiency-by-24/
A cost estimating relationship (CER) describes
the cost of a project as a function of design
variables. There are four basic steps in
developing a CER.

1. Problem definition
2. Data collection and normalization
3. CER equation development
4. Model validation and documentation
Model Validation and Documentation
The standard error (SE) measures the average amount by
which the actual cost values and the predicted cost values
vary.

Cost i : is the cost predicted by using the CER

yi; is the actual cost.

A small value of SE is preferred.

Model Validation and Documentation
The correlation coefficient (R) measures the closeness of the
actual data points to the regression line (y = b0 + b1x). It is simply
the ratio of explained deviation to total deviation.
Model Validation and Documentation
The correlation coefficient (R)
Values of R close to one (or minus one) are desirable in that they
indicate a strong linear relationship between the dependent and
independent variables.
•Thank you

Questions